Guest Columnist: What's next for the markets?

With the Dow in a swoon after soaring above 17,000 — a figure never before reached in history, and certainly one that was unimaginable just five years ago — now the biggest question on investors' minds is whether or not the markets correct further.

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By Rich Kersting

recordonline.com

By Rich Kersting

Posted Aug. 9, 2014 at 2:00 AM

By Rich Kersting
Posted Aug. 9, 2014 at 2:00 AM

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With the Dow in a swoon after soaring above 17,000 — a figure never before reached in history, and certainly one that was unimaginable just five years ago — now the biggest question on investors' minds is whether or not the markets correct further.

The truth is, both bulls and bears have some solid arguments to make their case.

While there is no question that the U.S. economy has strengthened, it is also clear that the recovery is shallow. Although unemployment has fallen to 6.2 percent (from 9.9 percent in April 2009), the number of people in the work force remains low. Similarly, while household debt has come down, wages have stagnated, and many Americans are still struggling.

One of the reasons I believe the bull argument is stronger is that consumers drive roughly 70 percent of all economic activity. The most significant factor affecting consumer spending is consumer wealth — do people feel like they can afford to spend money? When the answer is "yes," things tend to turn out pretty well; when the answer is "no," a slowdown in spending is likely.

Consumer spending continues to improve, and more Americans are finding their way back to full-time employment. More critically, the housing and stock markets are doing well. For most Americans, their homes and 401(k) accounts are their two largest assets. Historically, as people feel wealthier, they spend more.

Of course, not all signs are positive. One great challenge is the lack of lending. Banks are still gun-shy and are not offering enough money to small businesses and entrepreneurs to help kick-start the economy.

While economic growth in the second half of 2013 was very strong, 2014 seems plagued by investor and consumer unease tied to a variety of factors, including geopolitical tensions.

However, there are positive points regarding economic activity in the first half of the year.

Manufacturing increased and is expected to climb further. Moreover, given the relatively low levels of inventories, many expect an expansion of capital expenditures. In our view, U.S. manufacturing activity will likely return to levels seen in the early 2000s.

While bears can point to the sharp rise in stock prices over the past few years, anemic corporate earnings growth and elevated cyclical price-to-earnings ratios, other metrics point to fair values for stocks. For instance, corporate cash is at all-time highs, which we believe will lead to increased M&A activity, share-buybacks and dividends.

More significantly, we believe that the market has gone through a "stealth-correction." While major indexes have not experienced huge drops, several sectors have. For instance, biotech stocks sold off by roughly 20 percent in the first quarter of 2014, and small-cap stocks fell by nearly 15 percent as a group.

Conversely, high-quality dividend-paying stocks, which lagged in 2013, have been relatively strong performers this year.

In other words, while some stocks and sectors are clearly overvalued, as the bears suggest, others aren't. This means investors must do their homework and can't rely on a broad market appreciation.

Neither the economy nor the markets are sending clear signals right now. Then again, they rarely do. However, we believe that the bull case is strongest and that investors can thrive, if they are cautious and selective in their investments.

Rich Kersting has more than 25 years of investment experience and is a senior vice president at Gary Goldberg Financial Services, a boutique investment management firm based in Suffern with regional offices in Goshen and Fishkill. Additionally, he is the co-portfolio manager of the GMG Defensive Beta Fund (MPDAX). For more information, visit www.ggfs.com.